Portugal's next bailout review could drop the compliments

LISBON (Reuters) - Portugal’s leaders have generally done what their international lenders have advised, setting a pattern of government compliance and official praise. This week’s bailout inspection could be different.

For the first time since Portugal received its bailout in 2011, European Union and International Monetary Fund officials arriving on Monday will have to deal with new Deputy Prime Minister Paulo Portas, who nearly brought down the government in July by challenging the pain of austerity measures.

Portas threatened to take his small, populist center-right party out of government, which would have robbed it of its majority. The standoff won him promotion to deputy prime minister overseeing negotiations on the bailout.

He has already said last week that he wants an easing of the budget deficit goal for 2014, drawing a bold line between his stance and that of former Finance Minister Vitor Gaspar, who never swerved in his determination to stand by budget targets.

“It’s no secret that the government and troika (of lenders) had different positions during the (previous) bailout review about the deficit,” Portas said.

Gaspar resigned in July, citing lack of support for measures under the bailout.

“I don’t think there is any doubt that this will be the hardest review since the programme started,” said Filipe Garcia, head of Informacao de Mercados Financeiros consultants in Porto.

Reflecting that, bond yields have jumped higher in the past few weeks to above the 7 percent level where investors see dangers in 10-year debt, a trend that will not be helped by the U.S. Federal Reserve preparing to run down the bond-buying that had helped to pacify global markets.

Portugal descended into its deepest downturn since the 1970s when its debt crisis started three years ago and unemployment is near record highs after relentless spending cuts and the largest tax hikes in living memory.

While the Portuguese have grown increasingly angry at the austerity they have had to endure for three years, protests have been considerably less strident than in countries like Greece.

Many Portuguese are hopeful that the economic growth recorded in the second quarter - the first in two-and-a-half years - is the beginning of recovery. But further spending cuts could snuff out the prospect of a stronger economy improving the government’s finances.

“While Portugal has been able to avoid snap elections, the political limits of austerity have been reached and there is significant pressure to go for growth,” said Nicholas Spiro, managing director at Spiro Sovereign Strategy.

“The troika has already shown flexibility towards Portugal and does not want a Greek-style situation on its hands whereby it keeps cutting more slack with scant prospect of Portugal being able to stand on its own two feet.”

The political noise surrounding the review may be especially loud as Portugal holds local elections on September 29. The opposition Socialists lead in opinion polls.

Apart from the growing weariness about austerity among Portugal’s 10 million people, the Constitutional Court has consecutively thrown out several measures over the past year, including last month’s rejection of a bill that would have effectively allowed the state to fire public sector workers.

The court could still shoot down other measures, such as lower pensions and more working hours in the public sector.

RESISTANCE TO EASE GOALS

Portas and Finance Minister Maria Luis Albuquerque traveled to Frankfurt, Brussels and Washington earlier this month to talk to officials from the ‘troika’ - the European Commission, European Central Bank and IMF. That suggests talks on the next review have already started.

But the signals from the ‘troika’ suggest Lisbon may struggle to get any easing of austerity. Under the bailout agreement it is supposed to slash around 4 billion euros ($5.3 billion) in spending next year.

The head of euro zone finance ministers, Jeroen Dijsselbloem, said on Friday Portugal should stick to deficit reduction goals already agreed. “I don’t think it’s a good signal to keep the discussion alive whether the targets should be more or less,” he said.

Lisbon’s challenges are large, if it wants to exit the aid programme as planned in the middle of next year. A less stringent, precautionary lifeline to replace the current bailout programme could be discussed this month.

“It seems to me that a precautionary credit line is on the cards,” said Garcia. “I expect them to touch on that issue.”